Are they contractors or workers? It boils down to control

Published 12:01 am Saturday, February 26, 2011

NEW YORK — Those independent contractors you hired for your small business last year — they really were independent contractors, right? Or were they employees?

Many owners may not worry about the distinction, but they should. If the IRS decides that a company should have treated its indepen

dent contractors as employees, an owner could be liable for back taxes, interest and penalties.

Why it matters

Businesses have to pay the government what’s known as employment taxes for their workers who are employees. They include Social Security and Medicare taxes that are separate from the taxes that employees pay.

Employers don’t pay these taxes for independent contractors. So there can be quite a savings when a company uses independent contractors rather than employees.

The issue of independent contractor vs. employee has come up the past few years as many companies opted to take on freelancers rather than hire employees. Independent contractors are often cheaper because they don’t get benefits like vacation, health insurance and a retirement plan.

Who’s in control

Whether a worker is a contractor or an employee in the eyes of the government comes down to control. The IRS asks a pointed question: Does the company control or have the right to control what the worker does and how the worker does his or her job?

These are some of the questions you need to ask yourself: Who sets the worker’s hours? Is the worker required to work on your premises? How closely do you supervise the worker? Do you have two workers doing the same work and under the same circumstances, and you call one an independent contractor and the other an employee? If so, you’re probably in violation.

Another factor that goes into the process of determining independent contractor vs. employee is payment. Does the worker have a regular, guaranteed salary or wage? Does he or she get vacation pay or sick pay?

The IRS website, www.irs.gov, has a section devoted to this issue called Independent Contractor (Self-Employed) or Employee? It has details to help you determine a worker’s classification.

Paperwork

If you have independent contractors, you must issue them 1099 forms and send copies to the government to report how much you paid them. Your employees should get W-2 forms.

What if you realize you’ve made a mistake? You sent a 1099 to the worker whose hours you set and who took daily direction from you. And now you realize, that should have been a W-2 and you now owe the government for back employment taxes.

You can amend forms and returns that you’ve already sent to the government, and to the workers. And make good on the money you owe the government. But this might be a matter you want to take to a CPA or tax attorney. Let them guide you through the process so you can focus on making money.

If you don’t amend forms, and you don’t change how you classify your workers going forward, you run the risk of getting caught in an audit.

It’s a good idea to look at your workers now and be sure you have everyone classified correctly. If you do have employees rather than independent contractors, you have to regularly send your employment tax payments to the government.